How They Did It to Us Again

I’m an adamant believer of the stock market being the best leading indicator of what’s ahead for us. And while very, very few reporters know how to read a stock price chart, they get the job of reporting on and often analyzing the news for us.

How do I know the reporters can’t read stock price charts? Because, in everything I read today, I only see bullish analysis of our economy. In fact, I’m not sure a reporter knows what a stock price chart is.

There are few articles about the overextended American consumer, about what would happen if real estate prices plummeted, and about unfunded pension benefits. When’s the last time you read a newspaper article that questioned the United States’ need to attract $1.8 billion a day from investors outside the U.S. just to fund its deficit?

We have today’s media painting a positive picture for consumers, which I really believe misleads consumers into making the wrong financial decisions. The other problem we have experienced is too much access to easy money.

After the tech bubble burst, the Federal Reserve Board started to lower interest rates in an outright fight to stop our economy from a severe recession. The first mistake of the Fed was not tightening the monetary supply (raising interest rates) so the tech bubble would have not been a bubble in the first place.

The Fed then brought interest rates down to ridiculous levels. The Federal Funds Rate fell to 1%, and consumers borrowed like there was no tomorrow. Fed mistake number two: It took too long to raise rates. Economists had long looked at a 1% Federal Funds Rate as an “emergency” level.

A couple of months ago, the Fed came out and said it was going to start “measured” interest rate increases to get the Federal Funds Rate to a normal level. In recent remarks, the Fed has unofficially put the so-called neutral Fed Funds Rate anywhere from 3% to 5%.

Just imagine for a second that the Fed did get interest rates up to the mid-point of its neutral level, 4%. If the Federal Funds Rate was 4%, stock prices would be sharply lower and home prices would come crashing down. In fact, in an excellent research report from Phillips, Hager & North entitled “North American Residential Estate,” the authors concluded that if interest rates would increase one percentage point, then a 10% drop in U.S. housing prices would be required to maintain affordability at current levels.

The bond market, which is rarely wrong, knows the Fed doesn’t have a hope in hell of raising rates to its neutral level and that’s why the bond market has been rallying. Two Fed members, San Francisco Fed President Janet Yellen and Fed Governor Susan Bies, have now hinted that the Fed could put future interest rate hikes on hold if the economy doesn’t get moving.

What’s happened? The Fed brought interest rates down too far, too fast, for too long. Consumers borrowed and borrowed to the point where they are overleveraged like never before. If the Fed tries to raise rates too much, consumers would have a difficult time servicing their newfound debt and the whole economic deck of cards would come tumbling down.

My biggest concern: If this current economic environment is not a soft spot as we are being told (and I do not believe it is), Greenspan will not have much room to lower rates to get the economy moving. You’ve probably heard me say it before; Greenspan’s gun is out of bullets. Lowering the Federal Funds Rate back down to 1% won’t get consumers buying again because they are tapped out. Their collective debt situation cannot sustain the additional debt needed for consumer buying to jumpstart the economy.

August’s weak retail sales figure is a case in point. Yesterday, the U.S. Department of Commerce said retail sales fell 0.3% in August.

I can see the weaker consumer demand in the price charts of stocks. The Dow Jones Home Construction Index topped out in March and has been forming a perfect head-and-shoulders pattern. The Dow Jones Automobile Manufacture Index chart shows car maker stocks are close to their December 2003 price level. And the granddaddy of them all, the Dow Jones Retail Index collapsed in mid-August and is only now rallying from its oversold condition.

Lee Scott, the CEO of Wal-Mart, said it best in early September when he commented that the current business environment is “challenging.” If low-end retailer Wal-Mart is finding it challenging to get consumers to spend, isn’t that telling us something?

While I know some of my readers are likely thinking that consumers did it to themselves by overextending their credit so much, the reality is that an environment where consumers have no savings or borrowing room eventually hurts all of us. They did it to us again.